Welcome to the new Becker-Posner Blog, maintained by the University of Chicago Law School.

March 2013

03/31/2013

There has been an unprecedented drumbeat of accusations of unethical behavior by American (and foreign) business firms. The accusations that have gotten the most publicity concern, naturally enough in light of the financial collapse of 2008 and the worldwide economic depression that ensued and is still with us, banks (both commercial banks, like Citigroup and JP Morgan Chase, and “nonbank banks” such as Goldman Sachs and Lehman Brothers), related entities, such as mortgage brokers, hedge funds (accused of widespread insider trading), Ponzi schemes (such as Madoff’s); ratings firms such as Standard & Poor’s; pharmaceutical companies; other for-profit medical providers; law firms (accused of padding bills); manufacturers and retailers of foods (accused of engaging in misleading marketing practices that contribute to the nation’s obesity and diabetes epidemics); Internet search firms (such as Google) and social media (such as Facebrook) (accused of invasions of privacy); for-profit colleges and vocational schools (accused of misleading applicants). Although I am calling these accusations ones of unethical behavior, most of them violate either criminal or civil law. Business behavior that is unethical but probably not also illegal would include such things as packing a corporate board of directors with patsies who do not act as representatives of the shareholders (as they are supposed to) but are in the pocket of the CEO, the confusing disclosure of credit terms, exploitation of consumers’ difficulty in understanding interest rates, and hiring pretty girls to hawk new drugs to physicians.

There is nothing new about unethical business behavior. Nor is it confined to “business” in the sense of for-profit private enterprise. Most colleges and universities are nonprofit, but they have come under searing criticism of late for exorbitant administrative salaries, excessive tuition, and misrepresentations of the job opportunities of their graduates (law schools have become particular offenders in this regard). Regulators are accused of going easy on the regulated because they hope to be hired by a firm they are regulating after their stint of government service. State legislatures are accused of vote suppression, and donations to political campaigns are criticized as quasi-bribery.

Nor is it possible to say that there is more unethical behavior in business (broadly defined to include any provision of goods or services—the “market” in the broadest sense) today than there was ten or twenty or a hundred years ago. My guess is that, given the growth of regulation and expansion in legal remedies, there is less today than there was fifty or a hundred years ago. It is mainly anger at the banks, widely blamed for our economic troubles since 2008, and the increased scope and penetration of the electronic media, that are responsible for the fact that unethical business behavior is receiving much more publicity than in times past.

Yet the publicity on how widespread unethical behavior is should invite a critical look at the free-market ideology that is both a cornerstone of conservative ideology and politics and a highly influential current of economic thinking generally. It is the current typified by the popular economic writings of Milton Friedman and by Alan Greenspan’s contention (before the 2008 crash) that financial markets, and by extension markets generally, are “self-regulating”: they operate efficiently with little or no regulatory supervision by the government. Which we now know to be false, at least in the case of finance.

Competition is doubtless essential to the efficient production and distribution of goods and services. But it is not an antidote to unethical practices by producers and distributors. There are three problems. One is the limitations of negative advertising. Suppose a cigarette manufacturer discovers a way of reducing the incidence of lung cancer among heavy smokers by 50 percent. Can one imagine an ad that said: “if you’re a heavy smoker, switch to our cigarettes—it will reduce the likelihood of your getting lung cancer (as a result of smoking heavily) by 50 percent”? The advertiser would be poisoning his own well. Problems are often common to an entire market, and advertising that touches on a common problem tends to be self-defeating (“our airplanes crash only half as often as our competitor’ planes”; “airbags are more likely than our competitors’ to prevent your chest from being crushed by the steering wheel in a head-on collision”).

A second and related problem is created by cognitive and informational deficiencies that weaken theeffectiveness of consumers as enforcers of competition that enhances consumer welfare. For example, quoting prices that are not rounded to a dollar is a wasteful practice; it slows down transactions, increases record-keeping expenses, and is a drain on the U.S. Mint, because a penny costs more than a penny to produce. But sellers understand that a price of $7.00 strikes many consumers as substantially greater than a price of $6.99, and knowing this sellers are extremely reluctant to round.

Third, most competition is between organizations, and organizations are composed of people whose utility functions are not identical to that of the organization. Organizations are often nests of intrigue, where striving for personal advance can disserve organizational goals. This is true at the highest level; a CEO may be far more concerned with his salary than with the value of the corporation, and may (within limits of course) be able to promote the former at the expense of the latter. CEOs often as I said earlier try to pack the board of directors with friends and patsies, generously compensated for doing very little, so that the CEO’s salary will not be questioned and his tenure will be secure.

The legislative process is frequently and justly criticized on the ground that legislators’ horizon (oftenjust the next election) tends to be truncated, causing them to ignore long-term costs and benefits. But the same often is true in business, especially finance, where short-term profits may be enormous, as they were in the housing and credit bubbles of the early 2000s. It will often make sense from an individual trader’s perspective to take very great risks, if from a statistical standpoint the risks are unlikely to materialize until after substantial profits have been earned.

All the tendencies to inefficiency that are inherent in a market economy are actually magnified in the United States by the intensity of competition, as well as by inequality of incomes and the weakness of the social safety net, a prevalent free-market ideology that has given rise to strong political opposition to regulation, the enormous publicity that is given to wealthy people and the widespread public dissemination of affluent people’s incomes and wealth, the limited prestige of most careers that are not lucrative, the absence of aristocracy, which would provide an alternative ladder of success to money, and the American tendency to attribute financial success to skill and hard work even when it is largely attributable (as often it is, especially though not only in financial markets) to luck.

Extremely lax regulation, especially by the Securities and Exchange Commission, which regulated "nonbank banks” like the ill-fated Lehman Brothers) but also by the Federal Reserve, other federal banking regulators, and state insurance regulators, and spotty regulation of foods, drugs, and medical devices would not be problems if markets were really self-regulating, as Greenspan thought. They are not. We probably need stronger regulation. The danger is excessive regulation, which gave rise to the deregulation movement that began in the late 1970s, and had on the whole beneficial effects (though not in finance—the deregulators did not appreciate the potential macroeconomic consequences of a financial crisis). A balance is difficult to achieve. But the pendulum may have swung too far in the direction of deregulation.

The traditional case for competition and private enterprise does
not assume that it produces perfect outcomes. Rather, the case is that the
outcomes from competition are generally good, and certainly much better than those
in a government- dominated economy, or in any other alternative ever devised.
This is worth bearing in mind as we consider the topic for this week: business
and corruption.

Posner gives many examples of unethical and illegal behavior
by businessmen in recent years. These and other examples are certainly not
great advertising for private enterprise, but as he indicates, this is not
proof that such behavior has increased over time. Much more important, it is
not proof that unethical behavior is more common in business than in say government
or universities. After all, to take just one example, four former governors of
our own state of Illinois were sent to prison, and one is currently doing
extensive time in prison. for widespread corrupt practices.

Posner also argues that inefficiencies and unethical
behavior in business are magnified by competition, at least by the intense
competition among business in the United States. I very much disagree with this
claim since there is no convincing evidence or theory indicating that
corruption and inefficiencies are greater when businesses compete intensely.
Competition helps discipline business behavior by giving consumers alternatives
when they believe they are harmed by unethical business behavior. For their
part, companies usually try to get repeat business and keep the loyalty of
their customers by offering dependable goods and service. Monopolies need not worry
much about consumer loyalty since their customers have limited alternatives.

To be sure, I would not claim that competition always works
in this way, or that private and public monopolies are always inefficient.
Sometimes, as Posner indicates, consumers are fooled by the “small print” in
contracts they sign, or they choose products that are more harmful than they
anticipated. Sometimes too, businesses engage in unethical practices because
their competitors are profiting from these practices. But many examples
illustrate that, overall, competition surely helps consumers.

The postal system was a lethargic, rigid, surly organization
dominated by its unionized workers while it had a (government-enforced)
monopoly of regular mail delivery. Competition from FedEx, UPS, and the
Internet has greatly improved delivery of information and goods, and has even
made the postal system a little more efficient and a little nicer. Microsoft used its monopoly
power to extract surplus from consumers of Office and the Internet that it
dominated until faced with extensive competition from Google, Apps, Facebook, and
other ways to communicate and use the Internet. No one who has dealt with local
government-created private monopolies like Comcast will extol the virtues of
not having competitors to turn to for better services.

To take an international example, perhaps 40% or more of China’s
manufacturing employment is in state-run enterprises often with real monopoly
power. Private companies that usually face considerable domestic and
international competition dominate the rest of manufacturing, agriculture, and
most services. There is very widespread agreement that the private sector, not
public enterprises, has produced the dynamism that has driven the Chinese
economy forward. And when commentators speak about corruption in China they are
usually referring to local and central governments, and the regulators
appointed by these governments.

Nothing in my discussion, however, should be taken to imply
that competitive private sectors are always self-regulating. Economists were
already arguing in the middle of the 19th century that the financial
sector needed regulation and a government lender of last resort. Consumers
would have difficulty determining the safety of new drugs without regulations that
forced extensive clinical trials (but the FDA also has regulations that are highly
counterproductive). I can give other examples where regulations are beneficial,
but my main claim is that competition usually helps consumers whether in software,
groceries, or education. Competitive private enterprises, not governments or
regulators, have led the way in helping countries progress and reduce the
incidence of terrible poverty.

03/24/2013

Net illegal immigration from Mexico to the United States has
been essentially zero and perhaps even negative, during the past few years. Is
this entirely due to depressed labor markets in the US and tougher border
policing, or have longer run forces also been at work? The answer is that
fundamental changes in Mexico have contributed to the immigration slowdown, and
these changes will continue into the future. As a result, the highly
controversial American political issue of what to do about illegal immigration should
become much less important in the future.

Immigration theory divides the factors determining
immigration into “push” and “pull” forces. Push forces refer to conditions in
the countries where immigrants come from, such as low incomes, high levels of
unemployment, restricted opportunities for children, and religious, racial, and
other forms of discrimination that make living there unattractive. Pull forces
refer to opportunities in receiving countries, such as good earnings, jobs, and
opportunities for children. Individuals migrate when the combination of push
and pull forces make the expected gains from moving large enough to overcome
the substantial difficulties of moving, including separation from parents,
siblings, and even spouses for prolonged periods.

In all major immigration episodes, younger adults do most of
the moving since they are less tied down by family responsibilities, and are
more willing to take on the various risks involved in moving to another
country. For many years, the net gain from moving to the US has been very high
to young Mexicans with modest skills and education. The main reason has been
much lower incomes in Mexico, even for persons with jobs, and jobs were more
available in America since Mexico has had highly restricted labor markets.
These forces encouraged millions of younger Mexicans to endure the uncertainties
and costs of crossing the border illegally.

The Great Recession put a temporary end to easy availability of jobs
in the United States since at the height of the recession the unemployment
rate of low-skilled workers ballooned to about 16 percent. The difficulties of
finding good jobs even encouraged some illegal immigrants to return to Mexico.
That, along with tighter border patrols, greatly reduced the number of illegal
border crossings.

Once the American economy resumes its long-term growth path
with full employment (it has not been on this path for the past 4 years), the
economic pull from the US should return to where it had been before the
economic crisis. However, the push from Mexico has been decreasing and should
continue its downward path for the foreseeable future. One important cause is
the sharp decline in Mexican birth rates during the past couple of decades. Not
long ago Mexico was a country with high birth rates that produced many young
adults who had trouble finding jobs. Now, the Mexican total fertility rate
(TFR)- the number of children born to a typical woman over her lifetime- has
plummeted to about 2.25. This rate is only a little above the population
replacement rate of 2.1. Unlike in the past, the number of young people in
Mexico will no longer be growing rapidly over time, so that the numbers looking for work in the Mexican labor market will be on the decline.

The push from Mexico has also diminished because its economy
has been growing at a good clip during the past 9 years. Excluding the large
drop in 2009, the growth rate in real GDP has been over 4% per year. Mexico’s growth rate after 2009 considerably exceeds
the American rate of under 2%, which is remarkable since about 80% of all
Mexican exports go to the depressed American economy. One consequence is that the gap
between earnings in Mexico and the United States is narrowing. This clearly
reduces the demand to immigrate to America, especially under the difficult
circumstances illegal immigrants face.

The US must find a way to offer a path to citizenship for
the millions of illegal immigrants in the country. I have suggested elsewhere (”The
Challenge of Immigration: A Radical Solution”, IEA, 2011) that the best
approach is to sell the right to immigrate. Since illegal, as well as legal,
immigrants could buy this right, such an approach would help solve the problem
of illegal immigration.

But even if no new policies are adopted to reduce the flow
of illegal immigrants, the number of new immigrants from Mexico will not return
to pre-recession levels because economic opportunities are rising in Mexico,
and there will be fewer young Mexicans who need to find jobs.

Becker is unquestionably correct that economic factors provide the principal explanation for the sharp drop in Mexican immigration in the last four years. Either higher unemployment in the United States or lower unemployment in Mexico would tend to reduce Mexican immigration to the United States, and the combination of both trends in recent years has made the fall in immigration steeper than it would have been had one but not both forces been at work. The unemployment rate is still almost 8 percent in the United States but it has fallen to 5 percent in Mexico.

Although the decline in Mexican immigration is a good illustration of the economics of immigration, its significance for both the United States and Mexico probably is small. The United States attracts more immigrants than any other country in the world, and if it wants to offset the decline in Mexican immigration with an increase in immigration from other countries (including other Central American countries), it can do so effortlessly. How many Mexicans live in the United States rather than in Mexico probably has little effect on Mexico either, since Mexicans living in the United States remit large amounts of money to their relatives in Mexico.

Just as financial capital moves more or less effortlessly across national borders in search of higher returns, human capital as well is increasingly mobile. The ability of Mexicans to work on either side of the U.S.-Mexican border benefits both the United States and Mexico. Immigration reform now being discussed in Congress will if enacted reduce barriers to the international movement of human capital even further, and can therefore be compared to the successful post-World War II movement for the reduction of tariff barriers to international trade.

The diminution in Mexican immigration to the United States has greater political than economic significance. It has reduced the hostility to immigrants, a hostility that played a role in the licking that the Republican Party took in last November’s national elections, and by reducing that hostility facilitates immigration reform.

I do not think we should return to the era, which ended in about 1920, of unrestricted immigration to the United States. What has changed since then is that the country is considerably more crowded, and with an existing population in excess of $300 million additional population contributes to pollution, water shortages, extinctions, other environmental harms, infrastructure costs, and traffic congestion. In addition, the expansion in public benefits in recent decades can attract immigrants from very poor countries who have little prospect of gainful employment. So immigration has to be regulated. But so for that matter so does international trade in products, services, and financial capital. The goal of U.S. immigration policy should not be to discourage or encourage immigration, but to admit as immigrants (besides refugees and family members) only persons who have good prospects for making a net contribution to the U.S. economy.

Because of the difficulty of policing our long border with Mexico effectively, our large population of illegal immigrants is largely Mexican. Illegal immigration drives many Americans crazy, although I’m not clear why. Most illegal immigrants are productive workers and receive few public benefits. Their expulsion is neither feasiible nor (because illegal immigrants are a significant part of the U.S. labor force) desirable from an economic standpoint. The diminution in Mexican immigration should make it easier to obtain meaningful reform of our immigration policies.

03/17/2013

The question I consider is whether automation, technical progress, outsourcing, and the increasing complexity of products and services—all closely related phenomena—are reducing demand for workers, especially but not only those who do not have a high IQ.

There is a long history of exaggerated concern, rightly derided by economists, with the replacement and hence displacement of workers by machines. The idea at its simplest is that labor-saving devices whether in home or factory production, or in services, displace labor, leaving workers unemployed. The logic is simple. Over the course of my lifetime I have seen an enormous improvement in the quality of razor blades. A razor blade used to be good for one only shave; now it lasts weeks, even months. So fewer razor blades are made and therefore fewer workers are required in order to make them. The result is a worker surplus—but the logic that predicts this result is flawed. Workers made superfluous by technical advances constitute a pool of labor available to producers of new products and providers of new services. The existence of the pool places a lid on the price of labor, and therefore on the prices of the new products and services (since labor is an input into those products and services). Low prices stimulate buyer demand, which results in greater production, increasing the demand for labor. For centuries incomes have been rising in tandem with technological progress.

There has long been concern that automation of manufacturing was eliminating high-paying factory jobs, propelling the factory workers no longer needed into lower-paying service jobs. But this concern, too, is exaggerated. It overlooks the fact that higher pay for factory work is compensation for the fact that such work tends to be strenuous, monotonous, dirty or unhealthful, and dangerous. Compensation for disamenities is not a component of real income but an offset to a cost. It is the obverse of long vacations, which are an amenity of teaching and therefore a component of teachers’ real income.

But there is nothing inevitable about the virtuous process whereby automation and related negative effects on particular jobs merely shift workers to other jobs that are equally or more desirable. Workers may be highly compensated for possessing human capital that is specialized to a labor market that is shrinking. We are seeing this in law today. Because of automation, outsourcing, and more efficient management practices, the demand for lawyers is down, forcing many lawyers either to drop to lower rungs in the profession’s ladder or to leave the profession entirely for work in types of job which their human capital specialized to the practice of law has less, or maybe no, value to employers.

There is nothing new about this phenomenon, and in the long run labor markets adjust—fewer persons are applying to law school today and so eventually the lawyer glut will end. But at the same time there is no guaranty that labor markets as a whole will adjust smoothly to changes in demand in particular labor markets. That depends on the size and rapidity of those changes, and in turn on the size and rapidity of changes in automation, outsourcing, and management practices, all linked to technology in a narrow or broad sense: automation obviously, but outsourcing (for example of legal research to lawyers in Indiana) because of improvements in communications technology (especially online) and management practices because of advances in psychology, management science, human resources, computers, and communications.

If technological advance is very rapid, causing in turn a large and very rapid drop in demand in a large labor market, the economy may not be able to absorb the sudden surplus of labor in a short period of time. The result will be soaring unemployment that will retard normal market processes by reducing incomes and in turn production and therefore in the demand for workers. Take the case of the driverless car. This technology is advancing very rapidly and has great promise for reducing labor costs (drivers), traffic accidents (for example by eliminating drunk driving), traffic violations, and traffic jams (by optimizing speed, lane usage, and choice of routes and times). There are approximately 4 million truck, taxi, limousine, and bus drivers in the United States, not to mention gas station attendants and traffic policemen. Not all these jobs will be eliminated overnight, but they could go quite fast.

Apart from specific job categories, technological advances in products and services, along with greater outsourcing opportunities and free trade with other technologically advanced nations, increase returns to IQ and educational achievement relative to other worker qualifications such as strength, quick reflexes, and physical fortitude. The design, production, and control of robots require intellectual qualities that are not required in factory workers. Though there is evidence that IQs have increased over the last century and may continue doing so, and though some day it will be possible to increase IQ by altering brains, technological advances may continue for some time to increase the wage premiums for high-IQ workers and reduce wages of average- or low-IQ workers, thus increasing the rate at which inequality of incomes is growing. Not that the jobs of high-IQ workers are immune from the effects of technological progress; I gave the example of lawyers. Any job category involving a high degree of specialization is vulnerable. Think of the impact of photography on portrait painters, or of computers on typesetters.

These trends bear on the current debates over the size of government. Technological advances are increasing longevity, and with it an increase in the dependent population. By reducing demand for workers, and therefore employment and wages, in many labor markets, the same technological advances may be creating a second dependent population, consisting of people of working age and their children who cannot support themselves without public assistance that will either replace or augment wages. Republicans may therefore be tilting against windmills in thinking that the size of government can be reduced.

During the past 30 years the market for workers with few
skills has been weak pretty much everywhere. The reason is that economies,
including developing economies, have increased their demand for knowledge
workers at the expense of low skilled workers. The future is not likely to be
any kinder to workers with little education and few other work skills.

Various forces have favored skilled workers during the past
several decades; indeed, many of them began much earlier. Technological changes
and automation, including the development of computers, the Internet, and
electronic controls, have reduced the demand for certain types of skilled
workers, such as secretaries and clerical workers. They have increased the
demand for workers who command considerable knowledge, and who know how to
access any additional knowledge necessary to perform various tasks. The growth
in the stock of complex machinery has also raised the demand for workers who know
how to effectively use such machinery.

These trends toward greater reliance on knowledge workers have
been powerful not only in richer countries like the United States, but also in
developing countries like China and India. In China, for example, enrollments
in universities during the past twenty years have boomed because the demand for
educated workers and other skilled workers has sharply risen due to technological
transfers from Japan, the US, Germany, and other countries, foreign direct
investments, and the growth of exports.

When increased demand for more educated and other skilled workers
is matched by increased supply of these workers, the net gain from becoming
educated and skilled does not increase. Put differently, under those
conditions, the earnings of less skilled workers would not fall relative to
skilled workers. This is more or less what happened on balance in the United
States during the first 80 years of the twentieth century. But during the past
30 years, supply has not kept up with demand, so that the real earnings of low
skilled workers have fallen relative to those of skilled workers. Perhaps even
low skilled earnings have fallen in real terms.

This fall in the relative, and perhaps also absolute,
earnings of high school dropouts and other workers with limited skills has been
associated in the US and some other developed countries with a large decline in
the labor force participation of males with less than a college education. Some
have interpreted this decline in participation as evidence that there are not
enough jobs any longer for workers who do not have considerable marketable
skills.

Yet both theory and evidence contradict this overly pessimistic
view of employment opportunities. Theory states that the number and kinds of available
jobs depend not only on demands from producers and consumers, but also on the
cost of different worker types. When the cost of less skilled labor is low
enough, more workers are used to help with gardens, clean homes, help consumers
find the goods they want in retail establishments, and in countless other ways.
Essentially, the number of jobs that can be created is virtually limitless, and
it is mainly constrained by the cost of the labor.

Of course, obstacles like the minimum wage and “fair” wage
laws. Like the Davis-Bacon Act in construction, may prevent wages from falling to
levels that allow workers with lesser skills to find work. More importantly,
some persons with limited education and other skills may choose not to work or
to work only sporadically even when they can find jobs. The reason is that they can collect enough benefits from food stamps, unemployment
compensation, subsidized housing, Medicaid, “disability” pay, and other welfare
payments to enable them to do almost as well financially, and perhaps even
better, than they could if they worked and had to forgo most of these benefits.
Note the low unemployment rates of unskilled illegal immigrants, who do not
qualify for most of these welfare benefits. Their earnings also tend to be
above minimum wage levels.

In the longer run, the solution to the economic plight of
high school dropouts and other low skilled persons is, as I have argued in
previous blog posts, to ease the obstacles to boys and girls from poorer
backgrounds that prevent them from finishing high school and getting additional
training after high school, such as learning to drive trucks or work with
computers. In the shorter run, it would be desirable to replace the welfare
benefits that discourages many low skilled individuals from working with an expanded
earned income tax credit that does the opposite and encourages them to work.

03/10/2013

During the height of the Great Depression in 1935, with
unemployment rates around 20%, the US introduced a social security system that
made taxpayer-funded income available to workers if they retired at age 65 or
older. This was combined with a tax on the earnings of employed persons that
was supposed to finance the incomes to retirees. The purpose of the system was
partly to get older workers out of the labor force so that more of the then scarce
jobs would become available to younger workers.

At the beginning, this system was not expensive since
retirement payments were not generous, life expectancy at age 65 was then around
12 years, and coverage of the working population was quite limited. All this
greatly changed during subsequent decades. Social security retirement
incomes have risen greatly, partly due to highly generous adjustments for
increases in the cost of living. In addition, the average person who retires at
age 65 now lives for about 19 years, because life expectancy after age 65 has
increased greatly.

An even larger source of the increased cost to taxpayers of
benefits provided to older persons is the introduction of Medicare in 1965 that
provides expensive medical care for men and women over age 65. Social
security retirement income and Medicare-financed health care have become a
major part of spending: they are about 8% of GDP and 1/3rd
of the federal budget. These shares will rise greatly during the next couple of
decades unless major reforms are introduced into these programs.

One obvious reform would be to raise the age of eligibility
for both social security income and Medicare benefits. It is surprising that
while life expectancy of older persons has been growing rather rapidly for the
past several decades, and jobs have become less physically demanding, actual
retirement ages have declined from the 1930s. The average age of retirement is
now under 65 (about age 64) because a significant fraction of men and women
take retirement at age 62 when workers first become eligible to receive social
security retirement benefits.

In light of the increase in life expectancy after age 65 and
the decline in physically demanding jobs, it would be reasonable for the
eligibility age for social security to rise to 68 or 70. The average age of
retirement from the labor force for Japanese males is already only a little
below 70, which shows that much higher retirement ages is feasible. Persons who
are physically or mentally incapable of working would then opt for disability
status. This is a rapidly growing category in most developed countries, despite the
increase in physical and mental health of older persons, because of a weakening of qualifying standards. With more flexible labor markets for the elderly, such as
reducing the fear of companies that they will be sued for discrimination
against older workers, older men and women could retire from more demanding
jobs, and take jobs that are less taxing. This is what happens to older men in
Japan.

An increase in the average retirement age from 64 to 68
would save about 20 percent in social security payments since the average
number of years in retirement would be cut by about 20%. Similarly, an increase
in retirement age to 70 would save about 25 percent in social security
retirement benefits. Either change would also add significantly to revenue from
social security taxes since workers would be employed for several additional
years. Therefore, such increases in age of eligibility for social security
benefits would go a long way toward solving the looming social security
financial “crisis”.

Once a later age of retirement was introduced, it would be
much easier to raise the age of eligibility for Medicare benefits. The great
majority of older workers would be covered by their employers’ health insurance
plans, and would continue to receive the health benefits provided by these
plans. Coverage of workers in their later 60s would add to the cost of company
plans, but not by extraordinary amounts since medical spending by the average
person between 65-70 (in good part under Medicare) is only a little more than
10% greater than that of persons aged 60-65. Moreover, spending on
health care by older persons is lower under private plans than under Medicare
because the greater deductions and co-pays in private plans induce individuals
to economize more on their medical spending.

The savings in public health care spending from a higher age
of of eligibility for Medicare and social security benefits would not be as
large a fraction of Medicare spending as of spending on social security since
per capita spending on medical care gets much larger as people get into their
70s and 80s. Still, it would make a sizable dent in Medicare spending.

Higher ages of eligibility for social security and Medicare
benefits alone would not solve the looming entitlement budgetary crisis.
However, they would make big contributions toward the solution without
requiring radical changes in the level of benefits received by eligible
persons.

In principle, as Becker shows, increasing the eligibility ages for these costly federal entitlement programs would substantially reduce the federal deficit. But the size of the reduction would depend on the behavioral consequences, a complex and uncertain issue. For example, many people undoubtedly will increase the amount of private health insurance that they carry and also increase their savings for retirement. Most of these additional benefits will probably be provided by employers, resulting in an offsetting reduction in wages. Since fringe benefits receive favorable tax treatment, such a shift reduces federal tax revenues, increasing the federal deficit. Furthermore, more people will apply for social security disability benefits (the effect, if the application is successful, is that the applicant receives social security benefits before he reaches eligibility age) and receive them; in addition, the legal and other administrative expenses of obtaining such benefits are much greater than the expenses of obtaining social security at the age of eligibility.

Other people who lose eligibility if the eligibility age is raised will be able to substitute Medicaid, another costly entitlements program although less generous than Medicare and funded only one-half by the federal government (the other half is funded by the states). And because people between the ages of 65 and 70 are on average healthier than those who are older, the savings to the Medicare program from an increase in the eligibility age will not be proportionate to the number of persons who become ineligible as a result of the increase.

Becker mentions that one impetus to the creation of the social security program back in the 1930s was to create more job opportunities for young people. I think that that is or should be a concern today. In a society in technological flux, like ours, an age-top-heavy work force may be an impediment to economic growth. There is also considerable youth unemployment today. Although this is not the occasion on which to explore the issue of “structural unemployment,” I think it is at least arguable that automation, outsourcing, international competition, and changes in management practices may be shrinking the labor market. The more competition in labor markets the better for the economy, but the age discrimination laws shield older workers, to an extent anyway, from the competition of younger ones. (When I say “older” I have in mind not middle-aged men and women, but people in their late sixties who would be incentivized by the increase in eligibility ages to retire later.

Another problem with obtaining substantial economies from increasing eligibility ages is that of the phase-in period for the increases. In order not to upset people’s expectations (upon which many of their employment, savings, and insurance decisions may have been based) too drastically, proposals for increasing the eligibility ages for social security and Medicare invariably provide for a gradual phase-in of the higher eligibility ages. The phase-in for increasing the eligibility age for full social security benefits from 65 to 67, a change in law that was enacted in 1983, spans the period 2000 to 2022—thus taking 39 years from enactment to completion, with no changes in the first 17 years. A faster track to a lower deficit would be a reduction in social security and Medicare benefits immediately for affluent persons.

Unless the phase-in period is enormously long, in which event increasing eligibility ages would not be considered worthwhile, increasing those ages is unlikely to be politically feasible. Middle-aged people will think they are being “forced” to work at a time of their life when they will be “entitled” to be enjoying retirement. That is, people expect life to get better over time. Raising eligibility ages, especially for Medicare, because it is so generously open-ended, will be widely interpreted as telling people that life is not going to get better over time—because most elderly people don’t want to work.

Despite the problems I have emphasized, raising the eligibility ages for social security and Medicare deserves serious consideration. But perhaps equal or greater emphasis should be given to other ways of reducing the cost of these entitlement programs, such as measures, comparable those of employers and health insurance companies, to increase the incentives of hospitals and doctors that provide Medicare services to economize, as by eliminating redundant treatments and excessive screening for low-probability health problems. The Affordable Health Act tries to do this, and in addition the reduction in Medicare reimbursement that the Act mandates will put pressure on the providers to economize.

03/03/2013

A recent public statement signed by a number of law professors makes a variety of criticisms and suggestions regarding law school education, but there may be implications for higher education generally.

Here are the key assertions in the statement:

“Over the last three decades, the price of a legal education has increased approximately three times faster than the average household income. With the help of the federal student loan fund, some ninety percent of law students borrow to finance their legal education and the average debt now exceeds $100,000. More than one third of current students will graduate with debt above $120,000…The price of legal education has risen as the job market for lawyers has declined. Over one third of law graduates in 2011 did not obtain jobs as lawyers; the median starting salary of the class was $60,000…A graduate who earns the median salary cannot afford to make the monthly loan payments on the average debt. Thousands of law students are forced to enter Income Based Repayment (IBR), a federal debt relief program that allows reduced monthly payments, but with significant negative consequences for debtors and taxpayers…The price of legal education substantially affects access to the profession. The out-of-pocket cost of obtaining a law degree ranges from $150,000 to $200,000 or more for many law students…A recent report found only half as many entry level job openings as individuals passing the bar. Most knowledgeable observers believe that the situation is unlikely to improve even if the economy fully rebounds. More employers are relying on paralegals, technology and contract attorneys to do work previously performed by recent graduates, and cash-strapped public sector agencies are facing pressure to curtail legal expenditures…Law schools are themselves in an increasingly difficult financial position. After years of uninterrupted increases in enrollment and tuition, they now face a sharp decline in applicants. As it becomes harder for law schools to fill classes with quality students, all but the wealthiest institutions will face pressure to cut expenses. Yet at the same time, preoccupation with the annual ranking of schools by U.S. News and World Reports gives schools a perverse incentive to spend more in areas rewarded by the U.S. News formula. Two examples are expenditures per student and faculty-student ratios, which have risen dramatically in the decades since the rankings went into effect. Schools also have incentives to provide merit scholarships to attract students with high median GPA and LSAT scores, even though these applicants are unlikely to have the greatest financial need. Schools can do better in the rankings if they spend more in ways that could enhance the school’s reputation. The combination of rising costs, declining applicants, and perverse incentives puts the financial survival of some schools in question…Legal education cannot continue on the current trajectory. As a profession committed to serving the public good, we must find ways to alter the economics of legal education. Possible changes include reducing the undergraduate education required for admission to three years; awarding the basic professional degree after two years, while leaving the third year as an elective or an internship; providing some training through apprenticeship; reducing expensive accreditation requirements to allow greater diversity among law schools; building on the burgeoning promises of internet-distance education; changing the economic relationship between law schools and universities; altering the influence of current ranking formulas;and modifying the federal student loan program…”

If legal education were an entirely private activity, neither regulated nor subsidized by government, an economist would describe the situation as one in which a fall in demand required sellers to move down their maginal cost curve in order to charge a price that covered their marginal cost; that is, their demand curve would intersect their marginal cost curve at a lower point, implying a lower price (and also lower output). The demand for legal education is a derived demand from the demand for lawyers; if the demand for lawyers drops, so does the demand for legal education. If law schools fail to make a price adjustment, applications will plummet.

But they can lower price only if they reduce their costs. The problem is that by reducing costs, they reduce demand, because the perceived (though not real) value of a legal education is dependent on those costs as refracted through the lens of U.S. News & World Reports, which publishes a highly influential ranking of law schools. That magazine gives weight in its rankings to factors that actually bear no relation to the quality of a legal education, including the faculty-student ratio (important in some types of education but not in legal education) and the law school’s expenditures per student. In addition, accreditation of a law school depends on such additionally irrelevant factors as the size of a law school’s library even though all research relevant to the study of law by students can be conducted online.

The factors valued by U.S. News & World Reports are costly, but the federal loan program enabled the law schools to raise tuition, in part it seems because many law school applicants, inexperienced in financial matters and afflicted with the overconfidence of youth, underestimated the cost of a legal education. They are beginning to wise up and as a result the number of applicants to law school has plummeted—by about 50 percent in the last decade.

The obvious solution for the law schools is to reduce the size of their faculties and/or reduce faculty salaries. Although most law faculty are tenured, and so their salaries cannot be reduced, they can be laid off for economic reasons and, in lieu of being laid off, can agree to a salary cut. Law professors tend to be paid very generous salaries, especially relative to the amount of work demanded of them compared to the sweatshop hours of practicing lawyers and the intense competitiveness and resulting employment uncertainty in the law firm market nowadays. And law professors derive greater utility from their academic careers, quite apart from working conditios, than they would as practicing lawyers.

If law schools were permitted to cartelize, they might well embrace the downsizing that I have described as a solution to their economic dilemma. But they are not permitted to cartelize, and this creates hesitancy. The first law school to downsize will attract unwanted attention and, if none or only a few follow suit within a short time, its rankings in U.S. News and World Reports will nosedive. Law schools also have to worry about the possible adverse reactions of the accreditation authorities. Then too there is the hope that if enough law schools do take substantial measures to balance supply and demand, the law schools that do not will benefit, for example in being able to attract more of the affluent applicants to law school plus the applicants (often the same people as the affluent) who by virtue of native ability or a superior college education are likely to do well even in a very challenging legal marketplace.

What seems plain, however, is that the law school market is not in equilibrium; that it will move, quickly or slowly (probably the latter), to a new equilibrium; and that the new equilibrium is likely to involve smaller faculties and student bodies, a lower ratio of faculty to students, cheaper methods of instruction such as online, lower tuition, and perhaps looser (or no) accreditation standards, a reduction in the length of law school from the present three, to two, years, and the elimination of federal loans to law students.

The concerns flagged by the law professors’ statement that I quoted at the beginning of this piece are mirrored elsewhere in higher education in the United States. College and university tuitions have soared in general and many graduates are unable to find jobs in the fields that they thought their education was preparing them for. Students who do stay the full four years of college appear to obtain little economic advantage from college. U.S. News and World Reports‘ rankings are influential in other branches of higher education besides law, in particular its rankings of colleges, exerting pressure on colleges and universities to increase tuition, and increasing the dependence of students on federal loans. Reforms similar to those proposed for legal education may be necessary for other branches of higher education as well.

Posner gives an excellent discussion of the economics of
legal education. Although many reforms seem eminently desirable, such as
reducing law school programs from three to two years, I am optimistic that the
demand for lawyers will pick up again once the American economy returns to
long-term growth levels. The US remains a litigious society, and the number of
laws and regulations to be litigated are increasing, not decreasing.

Some reputable individuals are claiming that the advantages
of a college education more generally are greatly overblown, and that many of
the students who now go through 4 years of college are wasting their time, and
their own and their parent’s money. Yet an examination of the evidence shows
conclusively that for average college graduates, their education is a much
better deal even after 4 years of slow growth of the American economy than it
was a few decades ago.

Tuition and fees for college education in general, as for
law schools, have grown sharply since 1980: more than doubling in real terms
for 4-year private colleges and universities, and also for 2-year private
colleges, and public colleges and universities. Private schools have greatly
increased their scholarships and other financial support over this time period,
so the net increase in tuition is somewhat less. But no question the growth in
tuition has still been substantial.

However, even at elite private universities and colleges,
tuition is only about half the total cost of a college education. The remainder
of the costs is the earnings foregone resulting from being in school rather
than working after finishing high school. These costs have hardly grown at all
since the earnings of high school graduates have been rather flat in real
terms. Therefore, the total cost of a college education has grown by about 50%
since 1980, still a lot, but much less than the growth in tuition.

Offsetting this increase in costs has been the sizable
growth in financial gains from getting at least 4 years of higher education (as
well as gains in health, marriage, and other dimensions that I will not
discuss). The earnings of the average person with at least this much education have
grown during past 30 years from being about 40% higher than those of the
average high school graduate to being over 80% higher. This sizable growth in
this earnings advantage implies that a 4-year college education has remained a
good deal for the average student. Indeed, it has even become a better deal. By
that I mean that the average lifetime financial gain from going to a 4-year
college program has grown significantly, even after subtracting the increase in
net tuition, and that the rate of return on such an education has not decreased
over time.

Some critics of higher education have mentioned the growth in
the unemployment of men and women with a higher education during the financial
crisis and recession. The unemployment rate of persons with a bachelor’s degree
or higher has grown, from about 2% in 2008 to just under 4% at the end of 2012.
However, its growth has been less than that of persons with lesser education.
For example, the unemployment rate of high school graduates grew from 5% in
2008 to over 10% in 2010, and fell back to 8.3% by end of 2012. In fact, the
unemployment rate of persons with at least a bachelor’s degree is even now less
than were the unemployment rates of persons with lesser education before the
crisis struck.

Persons with less than four years of college do not earn
much more than high school graduates, and their unemployment rates are only a
little lower than that of high school graduates. Therefore, starting but
dropping out of college is not a good deal financially. Yet about half of all
men and women who start college fail to get a 4-year bachelor degree, and that
is a real problem.

Four years of college education remains on the average a
very good investment for students who can manage to pay the higher tuition
costs that schools now charge, even net of higher scholarships and other grants. The
aim of the federally subsidized student loan program is to help students who
cannot afford the costs of higher education, but many college graduates do not
earn a lot, and have large interest and principal repayments on their student
loans. As a result, many of them default on their loans, although the biggest
defaulters are those who went to two-year college programs, especially
proprietary schools.

This is not the place to go into details about ways to make
student loans less onerous for persons who are not earning a lot. One
possibility is to make interest rates contingent on earnings, so that higher
earners are charged more per dollar of loan than lower earners. This has the
risk of mainly attracting individuals who do not expect to be earning a lot,
but a well-designed loan program may be able to fix this “adverse selection”
problem.

Finding a more efficient student loan program may help
increase the number of students who take advantage of the large financial,
health,marriage, and other gains from 4 years of college education. Increasing
the number of these students should be a major goal of American higher
education policy.